Oil Surges On OPEC Extension News, But Will The Deal Work?

May 15, 2017 9:56am NYSE:UCO

oil drum

From Tyler Durden: Goldman Sachs, which has been pushing for higher oil prices with seemingly daily bullish research reports for the past month, and which underwrote the last Saudi Arabian bond issue and is expected to also manage the Aramco IPO (explaining the bank’s conflict of interest), released a note commeting on the latest development in the oil market, which sent the price of crude higher by 3% after Saudi and Russia oil minister agreed to extend the OPEC production cuts by another 9 months through the end of Q1 2018.


Specifically, Goldman writes that “today’s announcement will likely further extend the oil price rebound started last week on decent stock draws and low positioning, although the rally so far today has remained modest compared to the move that occurred last year when the OPEC cuts were first announced.”

Even so, Goldman’s oil analyst Damien Courvalin had some caveats. Specifically, he said that for the strategy to work, however, two things have to take place:

  1. compliance needs to remain high and
  2. long-term oil prices need to remain low to prevent shale producers from ramping up investment significantly more. In fact, an extension of the cuts should go hand in hand with guidance of future production increases by low cost producers, in our view, with an already notable emphasis by Saudi and others that oil prices will likely remain in a $45-55/bbl long-term range, in line with our forecasts. This leaves us reiterating our 3Q17 $57/bbl Brent price forecast and, with an increasingly likely extension of the cuts, raises our confidence that the oil market will shift into backwardation in 3Q17.

His full note below:

Saudi and Russia commit to a 9-month extension of oil production cuts

Saudi Arabia and Russia announced today, May 15, that they had reached an agreement to extend their oil output cuts for another nine months, through Mar-18. This announcement comes ahead of the scheduled May 25 meeting of OPEC members. Saudi energy minister Khalid al-Falih and his Russian counterpart Alexander Novak further pledged in a joint statement “to do whatever it takes” to reduce global inventories to their five-year average. In our view, this commitment to a longer than expected cut by the two largest participants of the output deal significantly increases the likelihood that all participants will agree to such an extension, with the longer duration likely helping to achieve high compliance through 2017.

Today’s announcement will likely further extend the oil price rebound started last week on decent stock draws and low positioning, although the rally so far today has remained modest compared to the move that occurred last year when the OPEC cuts were first announced. Beyond the element of surprise from today’s announcement, and the need for broader ratification by other participants, we believe that such a moderate oil price response is consistent with the shift in focus that we noted in our Commodity Watch last week, with the market focus now squarely on near-term inventory draws and participants more cautious on pricing forward fundamentals.

This likely reflects the disappointment in the pace of stock draws (although, as we have argued, this is seasonal and backward looking), the continued skepticism on the level of compliance with the cuts (although shipping data confirm the high April compliance) and the recent increases in Libya and Nigeria production. Libya output is back above 800 kb/d, from 400 kb/d in April, with targets above 1.0 mb/d; in Nigeria, the Forcados pipeline came back online last week and the Qua Iboe pipeline is being tested currently, with both together allowing output to reach its pre-disruption level of 1.8 mb/d. While we remain cautious on factoring in such a recovery in production given the ongoing local tensions, these combined volumes could largely offset the benefit of the extended cuts, with Kazakhstan already announcing that it needs new terms as well. Once again, this leaves focus squarely on near-term fundamentals, which we believe will continue to show steady draws in OECD inventories in the short term.

We believe that today’s announcement is consistent with OPEC’s desire to achieve both price stability and backwardation, which will help to slow the recovery in shale oil production by curtailing the market’s ability to grow future production through forward sales. For the strategy to work, however, we believe that (1) compliance needs to remain high and (2) long-term oil prices need to remain low to prevent shale producers from ramping up investment significantly more. In fact, an extension of the cuts should go hand in hand with guidance of future production increases by low cost producers, in our view, with an already notable emphasis by Saudi and others that oil prices will likely remain in a $45-55/bbl long-term range, in line with our forecasts. This leaves us reiterating our 3Q17 $57/bbl Brent price forecast and, with an increasingly likely extension of the cuts, raises our confidence that the oil market will shift into backwardation in 3Q17.

The ProShares Ultra DJ-UBS Crude Oil (NYSE:UCO) was trading at $17.48 per share on Monday morning, up $0.88 (+5.30%). Year-to-date, UCO has declined -25.17%, versus a 7.22% rise in the benchmark S&P 500 index during the same period.

UCO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #78 of 127 ETFs in the Commodity ETFs category.


This article is brought to you courtesy of ZeroHedge.


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